One U.S. Stock for the Global Retail Revolution

The war for online retail supremacy has begun, and the combatants are bloodthirsty — with good reason. Online retail has a long growth runway ahead with just one-third of global citizens having Internet access. But while skirmishes will never cease, the war has arguably already been won by the original gangster: Amazon.com (Nasdaq: AMZN).

The opening of Amazon’s virtual doors in 1995 marked a turning point in commerce. Starting with books in the U.S., Amazon has methodically extended its reach, offerings, and services across categories and countries — and devastated countless rivals along the way. Amazon now sells everything from peanut butter to zippers and grosses 40% of sales outside of North America, in such countries as China, Germany, and the U.K., among others.

Amazon hawks lots of goods to its 200-plus million customers, but more than 40% of items sold are from third parties who pay Amazon to act as a middleman. The beauty of these third-party sales is that they leverage Amazon’s massive platform and infrastructure and make for higher-margin sales than if Amazon sold the goods itself. Topping off the revenue pie is Amazon Web Services, or AWS, which essentially rents space on Amazon’s vast IT network to other tech companies at a fraction of what it would cost them to build it.

But while AWS is a growth engine and tech aficionados love blogging about it, the Media and Electronics & Other Merchandise segments are what butters Amazon’s bread. These units offer everything from music, movies, and books to Kindle e-readers, nappies, tools, computers, shoes, and more. The company’s best-selling item, its Kindle range, is Amazon’s version of the razor (Kindle) and razor blade (e-book) business model. Kindles might hurt margins today, but selling one product at a small loss to earn a lifetime of repeat purchases is very good business. Indeed, e-books are now a multi-billion-dollar business for Amazon and grew 70% in 2012.

Amazon1

Amazon’s growth has been astounding. Revenue has more than quintupled since 2007, and its customer base is not just growing, but accelerating. Amazon added more customers in 2012 than it did from 2006 through 2008. And while Wal-Mart (NYSE: WMT) — the world’s largest retailer — has seen flat sales per square metre over the past five years, Amazon’s revenue per customer increased more than 50%. Consumers are voting with their wallets — and they’re voting for Amazon.

Amazon2

The reason is simple: Amazon is convenient, cheap, and offers an unmatched selection. Amazon carries tens of millions of products, while the average Wal-Mart carries around 150,000 items. The large swathe of third-party sellers on the site adds to the depth and breadth of Amazon’s inventory, meaning you’re likely to find whatever you want, whenever you want. Amazon’s Kindle e-book store, meanwhile, offers more than a million titles that can be bought and downloaded in less time than it takes you to park your car at Westfield (ASX: WDC). And Amazon’s convenience edge will only sharpen as new distribution centres located near major urban areas cut customer wait times — and Amazon’s shipping costs.

Founder and CEO Jeff Bezos’ original insight was that an online store could carry a wider selection, customise shopping experiences to each individual, and hum along with far fewer employees. The proof is in the pudding, with superior inventory turnover and revenue per employee. Its revenue growth puts Woolworths to shame.

Amazon

Target

Wal-Mart

eBay

Woolworths

Annual Revenue (billions) $72.8 $79.6 $512.1 $16.4 $56.7
Revenue per Employee $823,387 $220,605 $232,786 $545,223 $298,670
5-Year Annualized Sales Growth

31.3%

2.7%

4.0%

12.2%

5.0%

Inventory Turnover             10.1           6.5           8.4            –         9.7
EBIT Margin

1.0%

7.5%

5.9%

20.7%

6.1%

Data as of July 2013.

Another source of fuel to Amazon’s fire is its negative working capital. Amazon usually collects from customers before it pays its suppliers, which makes for an extra boost of funds for this growing, capital-hungry company. Amazon Prime is another luscious form of float. Customers subscribe to Prime for $79 a year, which entitles them to free two-day shipping, instant streaming of Amazon’s growing collection of movies and TV shows, and the Kindle lending library. What’s doubly beautiful is that not only does Prime front-load dollars into Amazon’s coffers, but customers buy more goods from Amazon after they sign up. Higher sales volumes, even at low margins, boost Amazon’s buying power with suppliers, the value proposition for third-party sellers to saddle up with Amazon, and free cash flow thanks to Amazon’s uniquely valuable negative working capital. All this customer cash flowing in allows Amazon to get even bigger even faster.

I’m also a big fan of Bezos, who blends tech savvy with an obsession for customer experience and Warren Buffett’s indifference to Wall Street. As Bezos said in his 1997 letter to shareholders, he makes “investment decisions in light of long-term market leadership considerations rather than short-term profitability considerations or short-term Wall Street reactions.” Even better, Bezos is still young, hungry, and aligned with shareholders’ interests — he owns 87 million shares.

Amazon has ramped up spending on advertising and infrastructure. That is hurting profits today — and Kindle sales are eating into margins — but these value-creating investments are setting Amazon up for long-term dominance by building scale and a loyal, sticky customer base. Referring to another Bezos-ism, “When forced to choose between optimizing the appearance of our GAAP accounting [U.S. accounting standards] and maximising the present value of future cash flows, we’ll take the cash flows.” That is exactly the kind of long-term mindset we Fools love – and Bezos has the track record to back it up.

The Foolish Bottom Line

Amazon has dominated the online retail game with no signs of slowing down. In fact, it looks like Amazon is just warming up.

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Last updated: July 2013

This report was written by contributor Joe Magyer. Joe owns shares of Amazon.com. Employees and contractors of The Motley Fool, including Bruce Jackson and Scott Phillips may have an interest in any shares mentioned in this free report. These interests can change at any time. The Motley Fool has a clear and concise disclosure policy.